The Leather Pipeline - 15.05.18
15/05/2018
The past two weeks saw little activity as far as politics or the financial markets were concerned. However, there were some important decisions which could have a deep impact on the markets later on. This included the decision by President Trump to pull the US out of the nuclear weapons agreement with Iran and to reimpose sanctions on the country for at least the next six months.
Apart from the direct effects this might have on the conflict situation in the Middle East, it could also have a major impact on the business situation in many countries. Although the other members of the nuclear agreement, including the Europeans, did not pull out of the deal, business activity with Iran is going to be greatly hindered and the country’s recovering economy will be affected.
China will certainly celebrate the decision. Ties between Iran and China are likely to deepen; China is already the biggest oil customer and more business will no doubt be concluded between Iran and China rather than with the Western world. Although many people will welcome the decision, they should understand that this sort of conflict is never beneficial in the long term. The big question now is what is going to happen to the signed deals which are now up in the air.
Of course, there was an immediate impact on the oil market, with prices jumping between 3% and 5% right after the decision. The oil price has climbed well over the level of $70 for the barrel and is now approaching the $80 level.
The recent developments are bringing quite a lot of speculation to the market. Depending on individual interest, some are predicting prices will move back to triple figures, while others do not see the general balance between supply and demand as positive and expect that many oil producers are going to take advantage of the high prices and raise production. This will put a hold on prices.
As far as the financial markets are concerned, not much happened. The US Federal Reserve left interest rates unchanged with indications that further rises are likely. This has cemented the gap in interest rates between Europe and the US and strengthened the US dollar, which was climbing to levels around 1.20 against the Euro.
European currency was also weakened by the political situation in Italy, where the political parties have failed to form a government coalition. It seems there is very little progress and with the general economy remaining relatively vulnerable it is a threat to the recovery of the Eurozone.
Other than that, the labour markets generally continue to perform strongly with more people having a job and income rising. This applies for most countries and excludes only those who are in crisis for different reasons.
The gold price, which tends to react quickly to global uncertainty, couldn’t take advantage, falling rather than gaining in direct correlation to the firmer US dollar.
Market Intelligence
Most of the simple facts about the leather pipeline have been turned from left to right and upside down a number of times already. In the past fortnight, nothing new has happened. Everyone is watching the situation in the hope that leather demand shows the necessary recovery and changes the pattern of the market. In reality, this is not the time of year to expect this. So, we continue in this two-tier market where the premium and specialty departments perform solidly while the commodity and standard items do not see any improvement.
On the supply side, not much has changed, expect the gradual rise of global slaughter. This means there is a bit more raw material available, while demand for leather has been, and possibly still is, shrinking. Timing is another big problem because fundamental changes in the consumption of leather take quite a long time before they are reflected in the markets.
Everything is driven and decided by the brands and manufacturers because the consumer can only purchase and show their interest in products which are available online or in shops. This means that the basic fluctuation of demand as a consequence of the general economy has become very limited in its influence over recent years. When the big athletic footwear companies gain market share and the consumer is willing to follow their decisions about materials, the producers of leather have very little influence to change that because they never reach the consumer directly.
The past two years have been one of the best periods of consumer activity we have ever seen. If at the same time the consumption of leather is declining, we must accept that this is the real bad news. If we consider that at the same time the big consumer of leather, the automotive industry, was growing, it is hard to imagine where the market would be without the brilliant performance of car sales.
We are now at the beginning of the summer and we would be well-advised to make a realistic analysis of what all these factors mean to any business linked to the leather pipeline. For the leather industry, we can only repeat our position that we have to play the strong cards we still have in our hands: creativity, sustainability, value for money, and a strong feel for fashion.
Market potential
The question is how can we reach the final consumer. The first step, a very important one, is to create a clear strategy to combat anti-leather campaigns and demonstrate that it is a by-product of the beef industry. Almost every week there is another documentary in the media about the cruelty of beef production, whether it be at the farm, during transport or in the slaughter house. The campaigners are very happy to paint leather as an indirect supporter of these conditions and we have been unsuccessful in our attempts to make it clear that nobody in the leather industry accepts or supports the poor treatment or disrespect of these creatures.
Despite the anti-beef campaigning and the big noise being made by vegetarians and vegans, there is still a large proportion of the global community which still consumes beef and other meats. The simple logic is that hides and skins will continue to be available in the future and so there are just three options: turn them into a valuable product like leather; use them for other animal protein related products; or destroy them. If we accept that large groups of people are still willing to consume meat and are willing to consider leather as a material, there is still huge market potential and we shouldn’t be afraid of the big noise and the attacks against leather.
Ongoing challenges
For the time being, everybody must deal with the challenges posed by the current conditions. We think it is fair to say that we are principally suffering from two particular conditions.
One is the great interest in reducing the use of leather for production reasons; it seems manufacturers believe everything is easier and cheaper if you avoid using a complicated material like leather. The price pain may ease a little due to the rise in oil prices, but in an analysis of the total production chain it is still quicker, easier and cheaper to use alternative materials. The decline in leather consumption, particularly in the shoe industry, is not the only problem, however, and it is too easy to simply blame this for the current situation.
The second challenge we are facing is the restructuring in the Chinese market. The boom and rise in China created massive overcapacity, which is not just a problem for the leather pipeline. You can talk to people in other industries and you will find a similar situation in many of them. Industries which deal with raw materials are extremely vulnerable and sensitive to these sorts of boom-and-bust cycles. The price volatility of raw materials, the longer production times, and the fashion and production cycles have always left a lot of potential for maintaining obsolete production capacities for much longer than one would rationally expect.
However, the market still works and when the day comes, demand and prices don’t just fluctuate, they turn into weaker trends, leaving the victims at the side of the road. So, what we are seeing is not just a decline in leather consumption, but rather an adjustment of production capacity and consequently demand.
The Chinese government has taken action and the market conditions have accelerated the trend. As markets tend to overreact on both sides it is always difficult to figure out when and how the balance can be achieved again. The pendulum is still in full swing in the commodity part and it is hard to analyse how far the situation is going to go because there is not reliable statistical data to work with.
Lack of respect
This leads us to another subject we think must be discussed again and which is adding to the present problems in the leather pipeline. With a steep fall in raw material prices, respect for contracts has massively faded. Most of the trouble seems to be happening in Northern China. Since the sharp drop in prices following the APLF exhibition, requests for renegotiations of prices or simple failures to respect contracts have become more popular. Almost everyone that does business in that region is reporting cases like this.
Suppliers are expressing massive complaints about such behaviour, and rightly so. Some of the cases might have a history, with several customers pretending that they still have open claims or quality complaints from when the market went up. This cycle needs to be broken as the market decline is being significantly accelerated by contracts and shipments that need to be resold, especially if we take into account that deposits have often already been paid and the threat of high demurrage charges. This means the suppliers have to be flexible on prices. Only a handful of very strong suppliers are able to protect themselves by reselling these materials to reliable industrial clients.
Whenever this sort of thing happens, it is agreed that something has to be done about it. However, no action is ever taken and the next time it happens it is even worse. There are so many organisations, both locally and internationally, which should deal with these cases. We cannot think of a better solution than a neutral and independent institution where people can refer their cases, and which deals with them. We have this, and it is called arbitration. The term ‘arbitration’ is still mentioned in almost every sales contract, but we rarely see anyone using it any more. In fact, arbitration is a bureaucratic and complicated procedure, which is why most people try to avoid it. We can only ask that local institutions consider at least trying a less formal system.
A trade where the contract agreement is no more than a letter of intent cannot work. Not only is this a big risk for both parties in sharp market movements, it also represents an unjust punishment for those players abiding by the rules and honouring their commitments. Those actually playing by the rules and respecting contracts must feel like total fools when they see a neighbour who is not and is benefiting from an illegal action.
Splits and skins
The split market continues to be in the same misery as the hide market. Specialty, niche and high-quality materials continue to run their course. The rest are in serious trouble with huge unsold inventories of splits and their trimmings. The trouble is that many tanneries are trying to move from wet blue splits to lime splits. This was just shifted the problem from one market to another. Also, the demand for gelatine and collagen products is not endless and has been overstated in many cases. Consequently, there is more lime product coming to market in many regions of the world than the market can really swallow.
The skin market continues to move in its seasonal patterns. Once again, the slightly better performance of new season lambs in the double face market has made suppliers become too greedy. Asking prices for such materials have been raised and this has also influenced the generally good performance of quality fine wool skins. The market remains extremely fragile, however; increases in asking prices of $2-3 have not been accepted and sellers are reporting that neither Turkish nor Chinese customers are responding to their requests.
We are still very early in the season, but everyone has to be aware that buyers are currently purchasing raw material which is only seasonally available without really knowing what the market response will be when the finished products have to be sold after the summer. Higher oil prices mean we might have a chance in this segment, but it is a risky game to push prices significantly higher as this might kill the little activity we still have.
Customer quality
We do not have much to say when it comes to the forecast for the future. Half of May has already gone and we are approaching the hot season in the northern hemisphere and its associated holidays. There are no indications that the current market will change. In terms of leather demand, we are now in the quiet period.
It doesn’t seem like the problems in China will be resolved in the short term. If the material stocks people are talking about in that part of the world are real, the seasonal buying in July to refill the pipeline might also be disappointing, which would lead to the same problems as before. This means a pretty balanced situation for the strongest performing market segments and an uncertain outlook for the commodity one.
Everything points towards the quality of the customer being more important than the price you can obtain. Producers of commodity hides should definitely pay attention to the situation and take a more long-term view of it. Gambling on the highest price for the day could eventually result in rough returns.
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